24 Jan 2020
Sydney is often portrayed in the media as a city constantly covered in smoke. Admittedly the air quality isn’t as good as it was but since mid-December, smoky days have been few and far between. The terrible fires reported are to the south of Sydney itself. On some days skies can be somewhat hazy but there are many days with beautiful blue skies and the famous Sydney Hobart yacht race started in perfect conditions.
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I met with First State 12 months ago and since then Colonial First State Asset Management has a new owner and has moved premises. The investment team all work on a standalone basis and the change in ownership has had no impact on how they operate. I held an update meeting with Tuan Pham, a Senior Portfolio Manager. Tuan explained that the fund had endured a difficult 2018 but has seen a strong bounce back in performance in 2019, 7% ahead of benchmark, with three year figures also ahead of the benchmark index.
One of the key performance drivers of 2019 has been the exposure to residential, with several US providers of single-family homes such as Invitation Homes, Mid-America Apartment Communities and Avalon Bay Communities performing strongly. With the UK UNITE, the student home provider has also delivered strong returns as the stock has benefitted from the bounce in Sterling, which occurred in the fourth quarter of last year. Logistic (warehousing) Reits have also been strong performers including names such as Liberty Property, Prologis in Europe and Woodman Group in Australia. The value of logistic assets was demonstrated when private equity house Blackstone bought assets at a 5.4% net yield from Prologis, highlighting that the NAV of the company is set for a rise.
As a global fund, the portfolio can look to take advantage of niche ideas such as Kojamo, a Finnish urban property stock, which specialises in sustainable city developments. Some names exited the portfolio in 2019 including Ado Property in Berlin and Link Reit. Rental controls on the private housing sector were announced affecting Ado Property and Link Reit has moved away from its core product in the Hong Kong market, which isn't viewed as a positive change. Despite the difficulties from the Hong Kong protest movement, Swire Properties has a good development pipeline in Hong Kong and remains a favoured name.
The team expect the relatively benign global macro outlook to remain in place, with low interest rates and very moderate levels of inflation. With low unemployment and rising wages, there is a positive outlook for consumption. However, the team do have some concerns about the valuations of certain parts of the direct property market which are being driven by ultra low interest rates.
Having accounted for around 30% of the portfolio three years ago, retail exposure has now fallen dramatically to less than 5%. Residential and logistics are currently the two largest sectors in the portfolio. The team expect retail to continue to struggle globally due to the competition online for bricks and mortar operators.
The fund’s exposure is concentrated in well-regarded management teams operating in markets with healthy fundamentals and where asset values are increasing. Favourite areas are single family rental, industrial/logistics and healthcare, together with student housing. The portfolio is managed by an experienced team and continues to offer investors internationally diversified property exposure.
With my meetings taking place at the end of 2019, I took advantage of the New Year celebrations in Sydney. The fireworks in 2018 had taken place amongst intermittent thunderstorms and visibility was not at its best. After all the concerns this year, it was ironic that the weather for Sydney’s spectacular midnight fireworks was crystal clear.
My first meeting of 2020 was with RARE, to discuss their Infrastructure Income strategy, which has delivered strong returns to investors in 2019 and is now seeing significant inflows. There has been an addition to the three existing co-managers on the strategy with Daniel Chu joining Nick Langley, Shane Hurst and David Maywald. The investment process used by RARE has been unchanged over the last 10 years, with a focus on companies that have hard assets, provide an essential service and have revenue predictability with cashflow and dividend quality also assessed. The team model macro and company-specific scenarios, although macro is not as significant for this fund due to the yield criteria and individual minimum stock yield at 2.5%. The fund is looking to deliver income of 5% through the cycle and this has been achieved to date.
RARE incorporate ESG factors into the fund using Sustainalytics, a leading global independent provider of ESG and corporate governance research, supplemented by in-house work by the analyst team. ESG factors influence the required hurdle rate a company has to pass to be included on the buy list.
The easing of interest rates by the world’s major central banks in 2019 provided a favourable tailwind for infrastructure stocks, especially those with above average income, since investors were looking for relatively safe homes in equities as the global economy slowed. Whilst this is a defensive strategy, RARE still expect to deliver dividend growth of around of 4.5% p.a. over the next five years.
A positive for the fund last year was the exposure to UK utility names which were purchased due to the cheap valuations that RARE believed discounted the political uncertainty in the UK. The UK election removed the threat of a Corbyn government which had threatened to nationalise UK utilities on unfavourable terms for investors. Furthermore, 2019 saw satisfactory regulatory reviews for both the water and electric companies in the UK.
Some Brazilian names have also continued to perform well as the prospects for pension reform under Bolsonaro have improved. Whilst the Mexican stock market has been a weak performer, CFE Capital has been amongst the top performing stocks in the portfolio. Concerns about tighter regulation had seen the stock fall to levels where its dividend yield was 14%. However, analysis by RARE, including contact with expert networks on the ground in Mexico, suggested that the level of returns would not be impacted and that the stock was being purchased by Mexican pension funds, who are able to invest without withholding tax.
North American pipeline companies such as Enbridge have contracted cashflows not dependent on fluctuations in the underlying commodity price and have been strong performers. Australian Transurban, a high quality toll road business operating in Sydney, Melbourne and Brisbane continues to deliver growth through expanding its network. Tolls grow at least by CPI and as a result the company has enough to grow its dividend at around 5% p.a. RARE believe that this stock sees network effect benefits, both in terms of understanding how to pitch the projects based on forecast traffic flow, together with benefits from synergies.
Whilst the fund has high exposure to utilities at around 80% of the portfolio, this includes what are described as yield cos, which are contracted renewable energy companies in the States with a record of dividend growth that benefit from long-term contracts.
In summary, positives for the fund in 2019 were specifically in UK stocks ahead of the election and the strong performance of renewable yield companies. North American restructuring names such as Emera and Hydro One, together with pipeline names such as Enbridge and Gibson Energy, have also been excellent performers.
The fund has delivered on its performance target of OECD G7 inflation plus 5.5% before fees since inception. Central bank policy and the global slowdown has suited this fund which has a focus on economically insensitive names that also have quality dividend-paying characteristics. RARE have a well-resourced team of infrastructure specialists and clearly understand the asset class. This includes company specifics and broad-sector themes such as renewables. The fund is a defensive offering in terms of protection against recession risk and should continue to achieve its performance targets over the medium-term.
Before heading back to the UK I managed to fit in a trip to the national park at Botany Bay. The national park is a place of significant historical interest at it housed the first scientific collection of Australian flora from 1770 by Joseph Banks on the expedition led by Captain Cook. The specimens, such as the Banksia (named after the well-known botanist), can be seen today in the Natural History museum in London and Banksia still grows in Botany Bay today.
Graham O'Neill, Senior Investment Consultant, RSMR
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